Business, Legal & Accounting Glossary
A state where an individual or organisation can no longer meet financial obligations with lender(s) when their debts come due.
Insolvency is a financial condition experienced by a person or business entity when their assets no longer exceed their liabilities, commonly referred to as ‘balance-sheet’ insolvency, or when the person or entity can no longer meet its debt obligations when they come due, commonly referred to as ‘cash-flow’ insolvency.
In some jurisdictions, it is an offence under the insolvency laws for a corporation to continue in business while insolvent, though in others the business may continue under a declared protective arrangement while alternative options to achieve recovery are worked out. Increasingly, legislatures have favoured alternatives to winding up companies for good.
It is also usually grounds for a civil action, or even an offence, to continue to pay some creditors in preference to other creditors once a state of insolvency is reached.
(The term insolvency is often incorrectly used as a synonym for bankruptcy, which is a distinct concept, except in Germany. In some jurisdictions, a state of insolvency may lead to a legal finding of bankruptcy.)
In South Africa, owners of businesses that had at any stage traded insolvently (i.e. that had a balance-sheet insolvency) become personally liable for the business’ debts. Trading insolvently is often regarded as a normal business practice in South Africa, as long as the business is able to fulfil its debt obligations when they fall due.
In the United Kingdom, it is a criminal offence to trade whilst insolvent. However, there are insolvency practices (“Administrators”) which aim to protect the creditors of the insolvent individual or company and balance their respective interests. Alternatives such as Company Voluntary Arrangements and Administration in the UK reflect this shift towards a rescue culture.
When determining whether a gift or a payment to a creditor is an unlawful preference, both the date of the insolvency and the date of the bankruptcy – the liquidator or administrator will be able to recover money paid to a creditor as a preference if paid within six months (or two years if the creditor is a person connected to the company) preceding the date of liquidation and the company was insolvent at the time. In addition to unlawful preferences, liquidators and administrators in the UK may also challenge transactions at an undervalue, extortionate credit transactions, some floating charges and transactions defrauding creditors.
In the UK, the term bankruptcy is reserved for individuals; a company which is insolvent may be put into liquidation (sometimes referred to as winding-up).
Under the Uniform Commercial Code, a person is considered “insolvent” when the party has ceased to pay its debts in the ordinary course of business, or cannot pay its debts as they become due, or is insolvent within the meaning of the Bankruptcy Code. This is important because certain rights under the code may be invoked against an insolvent party which are otherwise unavailable.
The United States has established insolvency regimes which aim to protect the creditors of the insolvent individual or company and balance their respective interests. For example, see Chapter 11, Title 11, United States Code.
When determining whether a gift or a payment to a creditor is an unlawful preference, the date of the insolvency, rather than the date of the bankruptcy, will usually be the primary consideration.
Although the terms bankrupt and insolvent are often used in reference to governments or government obligations, a government cannot be insolvent in the normal sense of the word. Generally, a government’s debt is not secured by the assets of the government, but by its ability to levy taxes. By the standard definition, all governments would be in a state of insolvency unless they had assets equal to the debt they owed. If, for any reason, a government cannot meet its interest obligation, it is technically not insolvent but is “in default”. As governments are sovereign entities, persons who hold debt of the government cannot seize the assets of the government to re-pay the debt. However, in most cases, debt in default is refinanced by further borrowing or monetized by issuing more currency (which typically results in inflation and may result in hyperinflation).
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This glossary post was last updated: 24th April, 2020 | 2 Views.